Mutual Fund Myths

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A few myths about mutual funds.

Myth 1) While choosing between two MFs one should buy one with lower Net Asset Value(NAV).
NAV of a mutual fund depends on the duration for which the fund has been in existence and its performance. Rather than looking at the NAV one should look at the past performance to compare the funds.

Example: Let us assume two funds Fund A and Fund B. Suppost that Fund A is currently priced at Rs. 50 and Fund B is priced as Rs 20. Suppose you invest Rs 5000 in both funds, you get 100 and 250 units respectively. Assuming Fund A gives 20 % return and Fund B gives 10% return. The unit price of the funds becomes Rs 60 and Rs 22. Now your investment of 5000 in Fund A has now become 60 * 100 = 6000, and invesment in Fund B has become 250 * 22 = 5500. Thus we see the fund that looked expensive gives better return.

Myth 2) It is better to invest in NFO (New Fund Offer) than buying a existing fund.
Buying a mutual fund through a NFO only means that you are investing in a fund with no past performance. It is better to invest in a scheme with a known past performance record.

Myth 3) All mutual funds come with tax benefit.
Not all mutual fund come with tax benefit. If you invest in a Equity Linked Saving Scheme (ELSS), your investment can be shown under 80(c). These mutual funds come with a three year lock-in. If your fund invest more than 60% of the corpus into equity and you hold the fund for more than a year, the return made on the investment is tax free. Income from other mutual funds are treated as regular income for the investor.

Myth 4) NAV of a mutual fund always follows the Sensex.
It is possible that the NAV of a mutual fund falls even if Sensex rises and vise versa. Sensex or any other index track only a fraction of companies. The fund you have invested in can invest in these funds and also in other companies that are not part of the index. So it is very much possible that the index and your fund go in opposite direction. But if your fund is a diversified fund it is should follow the index over a long period of time.

Myth 5) It is better to invest in a mutual fund that gives good dividends.
When a fund gives you dividend the NAV of your fund gets adjusted by the amount. Thus the money that you get gets reduced from your investment. This option is mainly useful in ELSS where dividend received is like getting some of your investment back before the lock-in period expires.

Myth 6) You need a demat account to invest in mutual fund.
You need demat account when investing in stocks not for mutual fund. You can just need to fill up a application form, attach the check of the desired amount and submit the form at the mutual fund office or one of the customer service center.

Mutual Funds - Basics

Maniram once told me:
I have got five thousand rupees lying in my saving account earning a interest of 3-4%. I have heard that stock market gives better returns. I don't have a demat account. I don't know what stock to invest in. What should I do?

Sounds familiar?

Let us look at Maniram's problem. He wants to invest in stock market. If he decides to buy shares of some company, he will need a demat account and will have to spend about 700 to 1000 Rs for that. With the small amount of money that he has he would be able to buy only a few shares of a company. He will also have to decide which company to invest in, which requires a substantial effort.

Lets innumerate his problems
1) Initial expenses for investment.
2) Time needed to study a company.
3) Too small a investment to buy shares of more than one company.
4) Commission that he will have to pay on each transaction.


This is where a Mutual Fund(MF) can help him. Mutual funds take money from a invester and invests in the equity market on his behalf.

Now let us see how Maniram's problems get solved:

1) Initial expenses for investment: You don't need to open a demat or trading account for buying and selling mutual funds. Thus initial expense is zero.

2) Time needed to study a company: You won't need to study any company as you are not investing directly, but the mutual fund is investing on your behalf. They are financial market professionals and this task is best left to them.

3) Too small a investment to buy shares of more than one company: This problem no longer exists as the fund will have a large cumulative investment from many users and can easily diversify its investments in many companies.

4) Commission that you need to pay for each transaction: Most funds charge some fee as entry load. This charge is higher than commission paid while buying shares, but it get waived off if you purchase the units yourself (i.e. without going through a agent).

My suggestion: If you have money lying idle in your bank account, and if you are a medium to long term investor(three years or more). Go ahead and invest in mutul funds.

A few terms that you must understand about mutual funds

1) AUM - Assets Under Management
It the total worth of assets that are being managed by the fund.

2) NAV - Net Asset Value
NAV is the value of each unit that one holds in the mutual fund. NAV is calculated by dividing AUM by total number of units sold by the fund.

3) AMC - Asset Management Company
AMC is the entity that manages a fund for the investors.

More information about mutual funds can be found at http://www.amfiindia.com/

Latest NAV of all the funds can be found at http://www.amfiindia.com/navreport.asp